Fixed Exchange Rates
‘The key feature of countries with fixed exchange rates and high capital mobility is that their interest rates must be very closely aligned. Any interest-rate divergence between two
such countries will attract speculators who will sell one currency and buy the other until the interest rates are ‘equalized Consider a small country which pegs its exchange rate to a larger country. It might be Argentina, which has a currency board pegging its peso. to -the U.S. dollar. Because the small country s interest rates are the monetary policy of country, the small country no longer has an monetary policy. The small country’s monetary policy m~st be devoted to ensuring that its interest rates. are aligned with its partner’s. Argentina’s interest rates are determined in the United States.
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